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After a short career practicing international law in Moscow and Washington, D.C., Rich Smith retired to rural Indiana to take up a second career in investing and financial writing. A contributing writer for the Motley Fool, he also makes occasional appearances on Sirius XM Radio and NPR, and has been published on such varied sites as Yahoo! Finance, Creditcardchaser.com, Slickdeals.net, and of course, Aol’s DailyFinance. Rich covers everything from defense companies to retailers, and from hi-tech to personal finance.

When the financial crisis hit in 2008 and America's banks were teetering on the brink, the U.S. government made a controversial decision: Some of these banks -- Bank of America (BAC), Citigroup (C), JPMorgan Chase (JPM), Morgan Stanley (MS), and Wells Fargo (WFC), to name a few -- were too big to fail, and had to be bailed out, lest their bankruptcies pull down the entire U.S. economy.

The government immediately began a program to chop the banks up, require them to divest their subsidiaries, and slim down to a smaller size so that they would never again pose a threat to the integrity of the financial system.

Instead, the government gave them carte blanche to buy a bunch of smaller banks, gave them tens of billions of dollars of nearly interest-free loans, and encouraged them to get even bigger.

Bigger is Badder

So how's that working out for us?

Well, just last month, international megabank HSBC (HBC) -- technically a British bank, but with sizable operations in America -- settled a major case involving its laundering hundreds of millions of dollar in money of international terrorists, drug cartels, and even one notable member of the "Axis of Evil." For its crimes, it was punished with a fine equal to about four weeks' worth of profits, and told to go now and sin no more.

The reason: According to government regulators, HSBC is now "too big to jail." Doing anything more than levying a small fine to punish the bank for its crimes, apparently, would have a "systemic effect" on the American economy.

Um, Systemically Bad or Systemically Good?

Not everyone agrees with this assessment. In fact, deep in the heart of Texas, one government regulator is sounding off about the dangers of both too big to fail and too big to jail.

If you ask Federal Reserve Bank of Dallas President Richard Fisher, the solution to all these megabanks being "too big" is to make them smaller. Chop 'em up. Whittle 'em down. Or in the language that these megacorporations like to use in similar situations pertaining to their employees, "right-size" them.

In a speech last week, Fisher called America's megabanks "overly complex." According to the Independent Community Bankers of America, Fisher noted that "99.8 percent of the nation's banks are subject to failure, which ensures that these smaller institutions limit their risk." The nation's 12 largest "megabanks," in contrast, hold 69 percent of U.S. banking industry assets, and have been given a blanket guarantee that they're too big to fail.

Says the ICBA: "The result is limited market discipline and greater risk, even while these institutions enjoy the benefits of the federal safety net."

How to Fix It

To fix this, Fisher urges the too big to fail banks be, as the ICBA says, "restructured into multiple business entities [so] that only their resulting commercial banking operations ... benefit from the safety net of federal deposit insurance and access to the Federal Reserve's discount window."

He's not the only one advocating this. Last week, the ICBA argued that "splitting up and requiring greater accountability of too-big-to-fail financial firms will help reinstate financial market discipline and prevent future crises." It might also be good for investors.

Why to Fix It

Last week was earnings season for many of America's bankers -- an event that happens four times a year, when just about everyone who's anyone in banking reports their earnings for the preceding quarter. This particular week contained some surprises.

According to a Wall Street Journal summary of the week's results, Bank of America reported a "63% decline in fourth-quarter net income" last week. Citigroup, whose profits increased, saw a smaller increase than Wall Street analysts had projected, and suffered nearly a 3 percent decline in share price Thursday.

In contrast, the Journal says, a "regionally diverse group of smaller lenders has been thriving." PNC Financial (PNC), Fifth Third Bancorp (FITB), and BB&T (BBT) all showed "rising revenue, solid profit and expansion in lending volume" last week.

Why? In part, says the Journal, it's because these smaller -- small enough to fail -- banks are running "simpler businesses and [have a] sharper focus on local customers." Meanwhile, bigger banks suffer from "public disaffection with giant firms that are perceived as slow and unresponsive."

Good Things Come in Small Packages

The conclusion here is almost painfully obvious. On one hand, we have a group of a dozen or so megabanks that aren't just unaffected by the laws of economics -- "too big to fail" -- they're downright beyond the reach of the law -- "too big to jail." Permitting them to remain so just can't be good for the economy.

On the other hand, what we're seeing in the banks' earnings numbers today, right there in black and white, is that fixing too big to fail and too big to jail could be good for everyone involved. Split up the megabanks into smaller, more localized lenders, and not only can we improve their profits, but we can also improve the reputation of the bankers, and induce them to deliver better service to customers. And, last, but surely not least, just maybe we can avoid the next Great Recession in the process.

Banking Services 101

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George Hartzman

I am the George Hartzman Rolling Stone's Matt Taibbi wrote of the other week, and I believe Wachovia CEO Robert Steel bought Wachovia’s stock in a breach of trust, confidence and his fiduciary duty to shareholders, US taxpayers and our legal system, while in possession of material, nonpublic information.

On July 9, 2008, Robert Steel became president and CEO of Wachovia after working for Goldman Sachs from 1976 to 2004 and the US Treasury under former Goldman Sachs CEO Henry Paulson from October 10, 2006 until July 9, 2008. Mr. Steel was “the principal adviser to the secretary on matters of domestic finance and led the department's activities regarding the U.S. financial system, fiscal policy and operations, governmental assets and liabilities, and related economic matters,” according to Wikipedia’s biography. Mr. Steel most likely knew about other firm’s borrowings via his time spent at the U.S. Treasury Department.

On July 22, 2008, Mr. Steel personally purchased 1,000,000 shares of Wachovia’s stock as the company’s undisclosed Federal Reserve Term Auction Facility (TAF) borrowing reached $12.5 billion, which appears not to have been disclosed in securities filings audited by KPMG.

In an interview with CNBC's Jim Cramer On Monday, September 15, 2008, Robert Steel said "I think it's really about...transparency. People have to understand the assets and really be able to say, this is what I own... Complete disclosure. ...we can work through this with transparency, liquidity and capital. ...Our strategy was to give you all the data so you could make your own model. We tell you what we're doing... ...we're raising capital ourselves by basically shrinking the balance sheet, cutting the dividend, cutting expenses. We can create more capital ourselves that way... for now, we feel like we can work through this..." After Jim Cramer asked "Should there be any sort of quick regulatory relief from the SEC that would make life easier to be able to make your bank much stronger?", Mr. Steel responded "I don't think it's about my bank."

After not reporting TAF loans, Wachovia's CEO wrote "I, Robert K. Steel, certify that: I have reviewed this Quarterly Report on Form 10-Q for the quarter ended September 30, 2008 of Wachovia Corporation; Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report" on October 30, 2008.

Mr. Steel was at least aware of Wachovia’s Federal Reserve loans since July, 2012, if not the undisclosed loans to multiples of other financial institutions.

If Mr. Steel was “the principal adviser…on matters of domestic finance and led the department's activities regarding the U.S. financial system, fiscal policy and operations”, how could he not have known and acted on undisclosed material information?

On June 22, 2010, Robert Steel was appointed Deputy Mayor for Economic Development by New York City Mayor Michael Bloomberg, after which, Steel resigned his seat on the Wells Fargo board. According to Morningstar data, Mr. Steel owned 601,903 shares of Wells Fargo in 2010, which would be worth $20,446,644.91 as of October 26, 2012.

There are a few factual errors in the above article. Wells Fargo did not want to take the governments money, but was forced to. And, for this privalage it cost them 6% interest on $25 billion or $1.5 billion. All the banks had a similar situation. In addition, the government recieved stock warrants on all these banks. In the case of Wells it amounted to 110 million shares at a cost of $7.70 per share. Wells repurchased these government warrants at a cost of $850 million. So, in total Wells Fargo paid the Federal Government $2.3 billion + for taking money that it did not need nor asked for. The fact is that the Government made money from the banks as the vast majority paid the money back within a year or two.

Why is there not a cry for smaller government? It has the same problems of being so big that it can't keep up with what all it's parts are doing. And why haven't officials responsible for the mortgage debacle been prosecuted is simple. Barney Frank and Chris Dobbs are part of the Demorcatic Party and they controlled both houses of government after the mortgage debacle and they won't prosecte their own.